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Smith Manoeuvre (Maneuver) Mortgage Comparison – Part 1

I have teamed up with a mortgage broker, Melanie McLister from Canadian Mortgage Trends, to bring you a HUGE Smith Manoeuvre Mortgage comparison to help with your mortgage shopping. Here is the article that Melanie wrote:

The Smith Manoeuvre is nothing new to readers of this site.Many of you now know that it’s a popular tactic to make your mortgage tax deductible.Today we’ll discuss a key component of the Smith Manoeuvre—the readvanceable mortgage.

First, in case you’re unfamiliar, the Smith Manoeuvre works like this:

Get a re-advanceable mortgage (more on this below)

Liquidate non-registered assets (like stocks held outside of an RRSP) into cash

Use this cash as a down payment on your mortgage

Make mortgage payments like normal

Re-borrow $1 for every $1 of mortgage principle you pay each month

Invest that borrowed money at a higher rate of return than the loan interest you pay

There are a few twists so consult a good financial planner—and make sure the Smith Manoeuvre is actually right for you.Once you’ve done that, the next step is to find a good readvanceable mortgage.

A readvanceable mortgage has two parts:1) a mortgage; and, 2) a line of credit.In reality, both parts can be termed a “mortgage” because they’re secured against your house, but let’s not complicate things.It’s confusing enough that some lenders call their readvanceable mortgages “lines of credit.”

In a readvanceable mortgage, the lender basically gives you a new $1 loan for every $1 of mortgage principle you pay off.In other words, every time you make a payment you reduce your mortgage principle owing and your line of credit limit gets raised accordingly.

This list is a work in progress.It is not all-inclusive and its contents may change.As other lenders make their readvanceable mortgages known, we’ll add them to the list.

Also, keep in mind that some of these mortgages are not “optimal” Smith-Manoeuvre choices.Those mortgages are listed here simply for comparison purposes.

Each mortgage has unique quirks and each has varying rates and terms.This is where a professional mortgage planner can save you time and money.

Note that, while some of these mortgages can only be obtained through a mortgage planner, some can only be obtained directly through the lender.A reputable mortgage planner will always recommend the best product for you—even if it means steering you to a lender where he/she doesn’t get paid.We commonly refer people to banks that don’t have broker channels.We refer clients to contacts at these institutions simply as a courtesy to both the client and bank.In any case, we make sure that any banking representatives we deal with are highly experienced in the Smith Manoeuvre.

In addition, and contrary to what is sometimes written on the web, reputable mortgage planners generally do not charge fees to secure Smith Manoeuvre mortgages.

Yet another big question revolves around term and rate type.Homeowners often ask which term is best:a 1-year fixed, 3-year fixed, 5-year fixed, or 5-year variable.Clients typically want a 5-year fixed mortgage for peace of mind.However, as research suggests, 1-year fixed and variable-rate mortgages can give you the best lifetime interest savings.Ed Rempel, for example, notes that 1-year mortgages have performed better in every 5-year period since 1950.In the end, it’s your choice based on your risk tolerance.

Next week—in part 2 of this article–we’ll discuss various features specific to readvanceable mortgages.By the end of our review, you’ll know exactly what to look for in your next Smith Manoeuvre mortgage.

Melanie put in a LOT of work into getting this table together. Great job Melanie and thanks for all the effort that you put into it.

About Melanie

Melanie R. McLister is Editor of Canadian Mortgage Trends and a professional Mortgage Planner at Mortgage Architects.Melanie specializes in online mortgage planning for clients across Canada.You can read her mortgage commentary daily at www.CanadianMortgageTrends.com and reach her at www.MyVirtualMortgageBroker.com.

Important Notes

This article is for general informational purposes only and is not financial advice.Please talk to a qualified financial planner to ensure the Smith Manoeuvre is suitable for you.The opinions here represent those solely of the author.The author and her company are unaffiliated with Smith Manoeuvre Financial Corporation and Fraser Smith.

FT, Melanie,
This is a great informative post! I will surely look up the SM Mortgage Chart to see if I made the right choice ;-)

Another alternative that was not in your list is the Investors Group’s All-in-one. It has the same features as National Bank’s (they are in a partnership). However, instead of dealing with a bank for your investment, you deal with an investment consultant. It bring its pro’s and con’s but surely can be an interesting alternative for some individuals.

Hi FB,
Thanks for the idea. We work with IG as well and will get their product listed ASAP. We’re also waiting on TD’s info. If anyone knows of another good SM product we overlooked please let me know.
More to come! Have a great week,
Melanie

Wow… Very interesting concept. While mortgage interest is deductible here in the U.S., my particular tax bracket and standard brackets would probably not allow a plan like this to work on the U.S. side.

Anyway, very interesting and informative. I’m learning so much about Canadian finances here :)

A.J.
I know that your mortgage is tax deductible, however are investment loans are tax deductible as well in the US?
If yes, the SM could still be interesting even if you are already saving taxes…
Let me know!
FB.

It’s not that mortgage interest isn’t deductible. As a single father of three wonderful boys, I receive some sizable standard deductions in the U.S.

In order to get the mortgage interest tax break, I have to imtemize deductions. Even with a brand new first year mortgage, it is unlikely that the interest deductions and the other items I can take will exceed my standard deductions so they are essentially lost.

This process WOULD most likely work for someone else in the U.S. who has itemized deductions that exceed their standard deductions.

A couple of comments:
Envision & VanCity are not available throughout BC, but only within the catchment area of the respective Credit Union.

RBC Homeline allows you to make any form of automatic payment from the HELOC. So you could set up an automatic withdrawal plan for your investments, as long as they are of a form that can be managed by automatic debits. Likely other banking products allow the same. Be aware that some of the products that allow you to invest directly from the HELOC might limit the products you can purchase.

Oh, I found copying the info to a spreadsheet made it easier to interpret!

I can help narrow this down. We’ve been implementing the SM with any lender where it works for years. From our experience, the most important column in the survey for doing the SM is “Automatic LOC increases after principal payment”. Most of the above do not automatically readvance. Quite a few also only advance a minimum of $5,000 or $10,000 (or more).

The ones that do NOT automatically readvance make the SM virtually impossible to do. This means you have to apply every time for a readvance, and/or wait a couple of years until you can readvance their minimum. The odd one also has a fee per readvance (if you can believe it), which makes monthly readvances too expensive. Avoid any version with a monthly fee to readvance.

FT, I would suggest you take off the list any mortgage that does not automatically readvance. They essentially have no advantage over just getting a normal mortgage and CL.

National Bank, including IG, requires a $10,000 minimum readvance, not $500 as in the list.

One of the really surprising things we found from experience was that “Automatic investing from LOC” is hard to find out. The first 4 banks we asked all told us the wrong info – 2 said they allow investing directly from the CL but it did not actually work and 2 said it would not work but it did. That column above is what the banks will tell you, but a few of them are not accurate.

We are also big believers in short term or variable mortgages. One-year mortgages have saved money over 5-year mortgages 100% of the time since 1950.

I don’t understand the “sleep at night” argument for 5-year mortgages, since it means you are almost definitely wasting thousands of dollars. The average Canadian works one full year to make enough to pay the amount they waste in their life by taking 5-year instead of 1-year (or variable) mortgages. Also, your payment usually stays the same with a variable mortgage when rates change.

The mortgages above that don’t offer or are usually not competitive with discounted 1-year terms or variable rates are:

Hi Ed,
I am not quite sure on what you are referring to in regards to 10K readvance for National Bank and IG’s All-in-one. I do have an all-in-one and I can switch any amount from one sub-account to another.

This means that I can pay as little as a $100 of capital in a month on account#1 and borrow that $100 from account #2. I did not face the 10K minimum. I am very curious about it. Can you elaborate?

Yes, in the U.S. it’s a choice of one or the other, whichever is better in your particular case. The standard deductions are designed to be a “simplified” mechiansm (oops, somehow I worked simplified into a discussion on taxes, sorta weird but anyway) that allows you to avoid, but in those cases where a person believes their ACTUAL deductions are higher, you may choose to itemize to capture the higher deductions. If they are lower, you are still permitted to take the standard deductions instead. I hope that makes sense.

This list is meant to be a communal work-in-progress and we’ll keep tweaking it with new information as it becomes available.

I’ve tried to compile the basics and most lenders have in fact reviewed this page (we asked them to). Thus, most of the information comes direct from the horse’s mouth. There’s a load of data here, however, so there’s always the chance that a detail may get overlooked. This forum will hopefully serve as a good cross-checking mechanism.

Part II of the story will weigh the various parameters listed in the table in an effort to derive the best candidates on the list. To that end, David and Ed have both made excellent points, and successfully pre-empted my sequel article. :)

In any event, part II will overview the various product differences and reiterate some of David and Ed’s points, namely:

• Auto-LOC Transfers: As David suggests, most lenders do allow scheduled auto-electronic funds transfers that you can configure for automatic investment funds transfers. It’s not seamless (you still have to pull the investment trigger manually in many cases) but it is much more convenient than manual transfers each month.
• Ed’s point about automatic LOC increases and advance minimums is also spot on. For products without automatic readvances, it can be rather onerous to employ the Smith Manoeuvre. That’s not to say it’s always impossible, but often it’s a big hassle (going into the branch or calling the lender for example). For cases where you have to re-apply or pay a big readvance fee, look elsewhere.

Again, the “non-optimal” mortgage products in the list are included solely for comparison purposes. Many of the non-ideal candidates may soon become good candidates as several lenders told me they are developing automated processes more compatible with the Smith Manoeuvre.

The issue is whether you can immediately readvance the principal portion of your main mortgage payment. You are talking about transfering between subaccounts. Why do you have more than one subaccount? Are you doing some different strategy, or do you have your entire mortgage as credit lines (no actual mortgage)?

It sounds like you are not readvancing the principal, or perhaps you are not using all your available credit.

The issue with the SM is that if your mortgage payemnt pays $500 in principal, then you would want to immediately borrow that same $500 in a linked credit line.

With National Bank All-In-One (and IG), you need to pay down $10,000 of principal over a couple of years and then go into the branch and ask them to increase your credit line limit, so you can reborrow it to invest.

All of this procedure is not needed if you have a real readvanceable mortgage.

That’s interesting. I did not realize that you may not necessarily benefit from interest deductions in the US. Is there a rule of thumb – how large of an interest deduction would you need before it would be clear that it is worth claiming?

You are able to run an automatic investment directly from the HELOC at RBC? Our clients there have not been able to do it.

RBC has been the last to develop their readvanceable mortgage and was only rolling it out one area at a time last year. If they now allow direct investments (debits), that is a good advance.

We’ll have to pass this on to our RBC SM clients to try. Thanks for the tip.

We have found that most financial institutions do not allow automatic investments directly from their HELOC. A couple of the major banks are the only ones that allow this (although we thought RBC was not one of them).

Ed,
Nope. I have made automated payments from my credit line. If the investment cost arrives as a ‘bill’ or is a RBC product (ie. Mutual fund) I should be able to treat it as any other bill. I believe that I could also automate transfers from the HELOC to an Action Direct, or any other investment account, which then invests that money. This is NOT direct investing, it is simply a bill payment or money transfer, as I indicated in my original post.

I’m not sure I’d necessarily want direct investing, any more than I want to avail myself of all the automatic bill payment services that are available. While I enjoy the ease of electronic bill payments, I like to have the forced financial discipline (budget management) that having to pay the bills causes.

Hi Ed,
in fact, I only have an All-in-one on my property. So basically, my mortgage is a big Line of credit.
The interest rate is slightly higher than a conventional mortgage (it is at Prime) but it gives full flexibility to do anything you want.

Therefore, I do not have to go back to my bank every year to have my line of credit increase. I only have one sub-account for my mortgage and when I make a payment, I am allowed to withdraw the principal from a second sub-account (in order to track deductible interest) to invest the money right away.

Are there any other advantages to have a fixed portion as a conventional mortgage other than the interest rate?

Hi Mike,
I do not think that the interest rate is the only point that matters. For instance, you decided to take a 5 years term mortgage which is definitely not the best choice in an interest rate perspective. As you mentioned on your blog, you had other reasons which are totally understandable. Just to say that interest rate is an important factor, but surely not the only one.

Personnaly, I rather pay 0,5% more on my mortage and have all the flexibility in my payments and usage of my line of credit.

I don’t understand the “sleep at night” argument for 5-year mortgages, since it means you are almost definitely wasting thousands of dollars. The average Canadian works one full year to make enough to pay the amount they waste in their life by taking 5-year instead of 1-year (or variable) mortgages. Also, your payment usually stays the same with a variable mortgage when rates change.

Can you break down your numbers? I’m curious to see where you get your data for:

a) how much the average person “wastes” on 5-year fixed mortgages
b) why the average person needs to work 1 year to pay the interest difference between a 5-year fixed and 1-year fixed

Also, which major lenders specifically will allow you to keep your mortgage payment the same if variable rates go up?

I’ve always chosen fixed rates (like most Canadians) because it’s an insurance policy. People pay a premium for “sleeping at night” and I have no problem with it. If the worst case happened and my variable rates went up 1-2% I simply could not afford the payment increase. That would be devastating to me and my family.

Both you and Ed are corect about the National Bank. You can only link a line of credit to an “AOI”. If you have one line of credit as your mortgage and another as an investment line then the investment line will automatically readvance as you pay down the mortgage line.

Currently the National does not let you link a “mortgage” to the “AIO” however I sense this will soon change.

In the mean time, an apprasial is good for 2 years so you could select a “mortgage” and then for the next 2 years ask to have your line of credit increased by the amount you mortgage has been paid off. In the third year you would have to do new legals and an appraisal.

Finally FB, a variable mortgage is 0.8% less than prime. If your income is consistant then you will save on the variable. If you anticipate large bonuses or other large cash lump sums, above the what the variable will allow, then the line of credit may be best.

Dennis,
Check the following:http://primerate.ca/
The graph shows comparative rates. There are very few points where choosing a five year rate would be a better deal than a variable rate, or even a series of 1 year terms.

If variable rate mortgagor (VRM) and fixed rate mortgagor (FRM) pay the same dollar amount against their respective mortgages each month, VRM will usually discharge their mortgage at least a year earlier than FRM.

I’ll not provide a comprehensive list, but RBC website states: “With an RBC Royal Bank variable rate mortgage, your payment amount stays fixed for the term; however, the interest rate will fluctuate with any changes in our prime interest rate. This means that your monthly payments will remain the same, but if our prime rate goes down, more of your payment will go towards principal and if our prime rate goes up, more of the payment will go towards interest.” Likely other banks offer a similar product.

The biggest study of mortgage rates was by U of T professor, Moshe Milevsky. He compared variable at prime vs. 5-year fixed from 1950-2000. He found prime was lower 89% of the time and the average Canadian family wastes $22,000 (after tax) in their life because they took 5-year mortgages. Here is a link to the study:

I also have a study be a mortgage broker that he no longer has on the internet. He compared 1-year vs. 5-year mortgages since 1950 and found that five 1-year mortgages saved money 100% of the time! Even in 1980-85 at the peak of the interest rates, the 1-year would have been higher for 2 years and then lower for 3 – so the five 1-year mortgages saved money even then.

How can you sleep at night with a 5-year mortgage knowing you almost definitely wasted thousands of dollars??? How many more years will you have to work before you pay off your mortgage so that you can save the $22,000 you wasted?

David is right in his quote from RBC. The banks we use (and I believe all banks in Canada) don’t change their payments if rates rise until the end of the term. Confirm with your bank before you sign.

If you would have trouble paying a bit higher rate, even when the term comes due, you can negogiate to have your payment stay the same and just lengthen your amortization (unless you have a high ratio mortgage).

For those trying to pay down their mortgage more quickly, with a 1-year mortgage, you have no limit to your lump sum payments once each year.

We do the calculation for many clients as to whether it is worth it for them to pay the penalty to get out of their 5-year mortgage. I always feel bad for our clients that have paid large penalties over the years, even though they all saved more money with a new lower rate.

For us doing the SM, I would feel trapped in a 5-year mortgage. No opportunity to negotiate an increase in my credit line. No opportunity to negotiate freebees from the bank every time my mortgage comes due. No opportunity to refinance if things change for 5 years. Oh my god – I would have trouble sleeping at night if I was imprisoned in a 5-year mortgage!

1) which SM mortgage he prefers for most of his clients
2) do any of them pay the legal and interest charges for you to switch (I think manulife had a promotion a while ago where they would cover the costs).

In post 29 you refer to the potential advantages of using a variable, or short term mortgage over a fixed long term one, I have to admit the logic behind it sounded good & I have found most of your posts to be insightful and eye opening, I ran home to tell my wife how my plans have changed again!

That being said, I took a look at the link you provided and it really sounded quite good. He did his calculations & it looks like you’d end up ahead a good 80% of the time with a savings of at least 13K on a 100K mortgage…WOW… But then I started to look at some of the graphs and page 28 struck something funny for me, yes the rates for variable & short term out perform the long term just about every year, but what I couldn’t help noticing is that there are a lot of ups & downs, but I couldn’t help noticing how right now we look to be way down… The majority of the time looks to be above 6% by my eyes, I would think now is a good time to lock in (lock in when times are good & keep variable when things are bad…) looks to me like the only time the rates were lower than right now is in 1951.

Please correct me if I’m wrong, but I would think that there’s a fair chance there will be some fluxuation in the years to come as historically shown, but I would think the odds of rates going much lower are slim. If I knew the market would stay as is for years to come, then sure variable is a good idea. Also it would seam the lower the rates (like today) the lower the difference you will see between short term & long term

Hi,
I have read all the articles and still not able to make up my mind on best choices. I would like to pay off the mortgage quick and don’t mind riding the variable rate. I like the TD/RBC plan, can someone who has done this outrightly suggest what works the best.

Interest rates can be harder to predict than they often look. Especially in retrospect, it often looks as thought he direction that rates went is obvious.

It’s also funny how different people see different patterns in the same graph. When I look at the graph of the history of interest rates, I see that they peaked in 1982 and since then have been moving up or down in a 2-3% band that is coming down steadily.

Viewed this way, we are at the top of the band.

In addition to this, with all the issues with the subprime market in the US and a possible recession in the US (which would cause a slowddown here), almost every prediction I’ve seen is that rates are on the way down. The only question seems to be how far.

There is a demographic issue that you should be aware of, as well. I see what you mean that the graph appears that rates were low in the 1960’s, then high in the 1980’s and are low again now.

Demographics experts however claim this is a direct result of the baby boomers and was entirely predictable.

Interest rates are essentially determined by the supply and demand for money. For example, banks make most of their money by taking in money in GIC’s and lending it out about 2% higher as a mortgage. GIC’s are mostly bought by seniors while mortgages are mostly taken out by people from their late 20’s to 40’s.

IN the 1970’s and 1980’s, the baby boomers (a 20-year age group that makes up 1/3 of Canada’s population)were mostly in their late 20’s and early 30’s. At that age, they were busily buying houses and their parents (depression era), who are a comparatively small group, were buying very few GIC’s.

Therefore, the banks had a problem every day with people wanting to constantly take out mortgages and hardly any supply of GIC money. This excessive demand caused inflation as well.

So, the banks jacked up rates until they would get enough GIC’s to supply the demand for mortgages. Since there were so many more baby boomers in their 20’2-30’s than seniors, they had to raise rates to a ridiculously high level before it evened out.

Since then, the baby boomers are steadily getting older and the ratio of seniors to people 20-50 is getting higher steadily – and this trend will continue for several more decades.

Demographics experts use this to explain why rates went so high and why they have come down. If they are right, then rates should continue to decline for several more decades.

I think demographics are a major factor, but not nearly the only factor. For example, we may one day run out of resources (we aren’t yet, though) which could cause very high inflation and lead to higher rates.

However, Japan has a demographic breakdown now similar to what we will have in 20-30 years. Do you know what rates are like there? Shockingly low! 30-year bonds have been at about 1% until recently and savings accounts paid negative interest (zero interest and a fee to hold your money).

My point from all of this is that interest rates are not that easy to predict and that the trend to lower rates may well continue far longer than any of us may predict.

Add this to variable beating fixed rates the vast majority of the time and 100% of the time over 5 years, why would anyone ever want to fix a rate, especially for more than 1 year?

* 99.99999+% of people cannot accurately and regularly predict interest rates beyond the short-term. Economists with million dollar salaries can’t do it, mortgage brokers can’t do it, and financial advisors can’t do it.

* Don’t forget that if you choose a variable, and then decide to lock in, you might not get the best fixed rate at the time. Some of the big banks, for example, offer variable mortgage holders less appealing fixed rates when they want to lock in.

* Moshe Milevsky, author of the well-known variable/fixed rate research used by most people in our business, says:

“Obviously when long-term fixed rates were at 7% and short-term rates were going nowhere but down, it made a lot more sense to float.” But things have changed since then, he says. “I’m not telling everyone to go out and float. I’m trying to get people to think in a more integrated fashion about the other liabilities they have, like a corporation does.”

In short, variables are generally the best bet. But the fixed versus variable decision is not 100% cut and dry. It depends on the client’s risk tolerance and financial profile.

They say knowledge is a dangerous thing…. I have been lately reading up on the Smith Maneuver through FS book: is your mortgage tax deductible and various websites. I have come to realize that I am just a tad confused on how the process works and am wondering if there is any one out there that could point me in the right direction.

i follow the general principal of the smith maneuver- pay down the house mortgage and retake take that money through a tax deductible investment loan based on the difference of the house equity and your remaining mortgage ( the available difference of 75% of house worth). The net gain is simply the investments need to beat the interest rate on the investment mortgage. But then things get fuzzy!

The questions I have:
• Through this process, will I still maintain my existing mortgage (i.e. through MCAP) on my house and have a second loan- the investment loan, or will everything be tied into one ‘mortgage’ consisting of the house mortgage and the investment loan.
• It is argued to hammer down the mortgage (bad debt) as soon as possible with all ammunition at hand! if you need to change mortgages, do these mortgages typically come in fixed/variable on varying term length and with favourable pre payment options.
• How does the readvancing to the investment loan work- is completed on a monthly basis coinciding with the mortgage payment or do you request one lump sum investment loan based on the difference owing and 75% of the house appraised value).
• For the mortgage payments- it seems that you pay your house mortgage down at the set predetermined rate and would have to also pay down the investment loan component. As a result, it appears that the total sum of $$ required for the smith maneuver is greater then the existing mortgage payment. However, the SM argues to be cash neutral. What am I missing in this equation.
• With house prices increasing, how often should one get their house re appraised to maximize the SM benefits.
• Can you do self directed DRIP investing through the SM to avoid the MER of mutual funds.

Yes, the implementation mechanics of this beast throw my off a bit. Is there any SM implementers or a SM group out there in the york-south simcoe (Ontario) corridor. if so, I would appreciaite the opportunity to discuss the SM with you further.

My comments are based on a study by a mortgage broker. He actually compared 1-year to 5-year mortgages since 1950 and found that five 1-year mortgages saved money over a 5-year mortgage 100% of the time since 1950.

I had always thought that the exception was the early 1980 when mortgage rates sky-rocketed, however his study shows that even a mortgage in 1980 would have resulted in the 1-year being lower than the original 5-year mortgage 3 of the 5 years.

His study does not include variable, but since they are usually not much different than short term mortgages (and most often lower), I am assuming the same conclusion would apply.

Moshe Milevsky’s study shows variable rates and that they have been lower than 5-year fixed 93% of years, but it does not show a comparison of a 5-year to 5 years of variable rates.

Unfortunately, the broker changed companies and does not have the study on his web site now.

We used to agree that the choice should relate to the client’s risk tolerance and financial profile, however we have come to the conclusion that is one of those “conventional wisdom” items that is actually not true.

We now believe that 5-year mortgages are only for those that prefer to waste thousands in interest. Given that longer term interest rates are hard to predict and the odds are over-whelmingly in favour of variable, why would anyone want to gamble against those odds? You would need to be very confident that rates will rise sharply and stay high for a long time.

In normal interest rate situations, 5-year mortgages are 2-2.5% higher than variable rates. Recently we have had flat rates, but flat rates have historically always led to declining rates. This is happening again this year.

We once thought that those who were very tight and might lose the home if rates rose should lock in. However, we have come to believe that this would mean those that can least afford it should be the only ones to waste thousands on interest. Better advice for these people would be to save the difference in mortgage payment or setup some other credit facility to pitch in if rates do rise a lot.

Perhaps our clients are not representative of the public, but we have not found a single case in the last 15 years where we would recommend anything other than a 1-year (or less) or variable mortgage. Even in retrospect, I can’t think of any time when this did not save our client money.

– Before the questions, you mentioned that the net gain is that the investments need to return more than the interest rate on the investment loan. This is not actually true. They need to beat the investment loan over the long term after tax. The investment growth is compounding, which may or may not be true of the interest (depending on how you set up the SM). The loan interest is fully tax-deductible every year, while the growth of the investments is tax-preferred and can be deferred many years into the future with tax-efficient investments. In general, over 10-15 years the investments would need to make about 2/3 of the interest rate on the investment loan to break even.

– From your questions, it does not sound like you have the right products. MCAP does not have a readvanceable mortgage that works with the SM. You also should have, in most cases, an investemnt credit line, instead of an investment loan. A readvanceable mortgage is a mortgage linked with a credit line so that you gain credit available in the credit line with each mortgage payment. It is one product, but the mortgage is a subaccount within the credit line.

– Yes, most readvanceable have variable and fixed rates. If you are trying to pay it down, you should stick with a variable or 1-year mortgage. Variable is particularly adviseable now with rates declining. Prepayment terms are similar to other mortgages, but fully open readvanceable mortgages are also available. If you want advice on what mortgage to get, you can contact us through “Ed’s Mortgage Referral Service” referred to elsewhere on MDJ.

– Readvancing to invest is normally done with each mortgage payment eg bi-weekly. This is easily done with a readvanceable mortgage, but will be very difficult the way you have it with an investment loan.

– You are missing the interest capitalization. You borrow the money from the investment credit line to pay its own interest. Again, this is easily done with a readvanceable mortgage but will be very difficult the way you have it with an investment loan.

Generally, getting your home reappraised so you can invest the difference is best done as often as you can without paying any fees. We have found that every 2nd year we can get a free appraisal, and often every year if there is some other refinancing happening or if your home rises signficantly in value in one year.

You can use a DRIP plan instead of mutual funds if you can get the cash flow to work. You would then probably just buy once every so often, instead of investing bi-weekly as you can with mutual funds. You are restricting your investment choice if you only use DRIPs and they tend to be only very conservative large caps. If you look at MERs, we recommend to look for value for your money, instead of focusing only on cost. We use mutual funds managed by “All-Star Fund Managers” that have long term track records of beating the indexes by wide margins (after the MER) and that we believe will continue to beat the index over time even in very different market conditions.

rpost said”• For the mortgage payments- ….. What am I missing in this equation.”

If you look at cannon_fodder’s spreadsheet, elsewhere on this site, you can see how it works. You end up investing a lesser amount each period, as a greater portion of the investment amount pays the interest on the HELOC. The real growth in the portfolio occurs only once the full conversion occurs, and you have the full valus of your mortgage payment to contribute to your portfolio.

rpost also said: “With house prices increasing, how often should one get their house re appraised to maximize the SM benefits.”

This is a balancing act. It is possible for your home to increase in value at a rate greater than your ability to service a loan at it’s new value. Thus, while you may be able to obtain an increased appraisal value, you might not be able to use that increase.

Smith does not indicate that you should re-appraise; his claim being that you keep your costs within the original mortgage amount. While this may have been to help with the financial comparisons; re-appraising steps you outside the original premise.

Yes, our contact information is there. A good idea for you would be to come to one of our seminars. They are educational seminars about the Smith Manoeuvre and related financial issues – not sales presentations. They include some of my favourite “conventional wisdoms” – things most people believe that are actualy false. Attending the seminar is a good, informal way for us to meet and see whether we will want to work together.

The dates are on our web site, but the next ones are Feb. 26 & 28. You will need to register ahead of time to get in.

Hi FT, This is a great post and very well written. However, I ran my own calculation of my situation and number does not seem right. Please help me point out where i am wrong using SM

I am purchasing a house at 540K. I made down payment of 120K (22%) so i should qualify for HELOC of 420K at 4.75%.

Everymonth, I will make a payment of $732 in principle and $1663 for interest. Then i use this $732 to borrow $732 to invest. The interest on this loan $732 per month is $2.9. Is this $2.9 dollar is the amount I use for my tax deduction?

I really want to learn this kind of calculation so sorry for all my questions to make sure i can calculate correctly.

I run the calculation again.
The first month, interest i paid for LOC is $2.9 and following months $5.81, $8.73,$11.66 . Are they correct? if they are, I sum up 300 months, the total is 202,064. Multiply by 40% only gives me $80,825. What am I missing?

Here’s a warning to those of you set up with automatic mortgage payments of any kind (regardless of implementing the SM or not).

We just set up our BMO Readiline in July to have semi-monthly payments – supposed to be on the 15th and last days of the month. Well, in the month of August, the payments came out on the 18th and, somewhat unsurprisingly, today (the first business day after the 31st).

I contacted BMO and have to wait until the branch that holds our mortgage calls us up but with everything electronic, this is inexcusable. Even though we have a payroll system which can automatically deposit money on the last business day before the 15th and the last business day before the end of the month, apparently BMO’s system couldn’t do this for us. The net result? Almost an extra $100 in interest charges going into their pockets.

Please do yourself a favour and look over your banking statement carefully for this kind of behaviour which is to the bank’s advantage, not your own.

I contacted BMO through the customer service line and was told that the branch (that holds our mortgage) would get back to me that day. They never did. However, the financial investment representative who got our great rate on the Readiline did contact us this week after my wife called her (the BMO rep was on vacation and wasn’t aware of this issue).

The net of it is that I made a mistake in my assumptions on how they accrued interest and, while there was some additional interest charges because the money wasn’t taken out as we had expected, the total was less than $1.00. Our first two mortgage payments didn’t come out during a normal pattern, but we are now where we should be.

So, while I understand why they took the money out after the expected dates, I still don’t like it. Regardless, the additional interest was not enough to be a bother.

And, to show how much BMO was willing to accommodate, they offered to return the additional interest charges and add 100 Airmiles to our Airmiles account.

Nice job handling this situation which I unfairly made bigger than it should have been.

Now, I shall go have a nice cold drink to wash down the crow I just ate.

TD HELOC generally works better for the SM than Scotia STEP. The downside for TD is that they don’t offer variable rates, but they are very competitive on 1-year fixed, which is what we are recommending right now. The upside is that they allow investing directly from the credit line, which Scotia does not allow.

Also, the Scotia STEP is inconsistent from branch to branch. It seems that every one of our clients with the STEP has a different product – some readvance automatically & some don’t, some have a minimum before they can readvance and some don’t, some can be converted to automatically readvanceable with one form and some don’t, some branches will manually readvance and transfer to a chequing account for no charge in order to match other SM mortgages and some don’t.

Generally, Scotia STEP is okay, but you have to check out all details carefully. There are several better options for SM mortgages.

* Scotiabank does, in fact, allow direct investing from the STEP. Maybe that has changed since the last time you tried the STEP? If, for example, you have a ScotiaMcLeod account you can move money instantly from the line of credit to your investment account online. Scotia will also be adding the ability to instantly move funds from the LOC to a Scotia iTrade account. We hear this should be done later this year and it will be great for people who want a self-managed solution with low transaction fees.

* We use the Scotia STEP for many of our Smith Manoeuvre clients and they prefer it over the TD HELOC for various reasons:

—> The STEP has an open or closed variable-rate mortgage option whereas TD does not
—> The STEP has a hybrid mortgage option (part fixed/part variable) for interest rate diversification
—> The STEP allows for different fixed and variable terms in the same mortgage. (e.g. part 1-year fixed, part 5-year fixed, part variable, etc.)
—> The STEP has higher lump-sum pre-payment options (you can often get 20% on exception instead of 15% at TD)
—> The STEP has an optional VISA card linked to the LOC (not the investment sub-account of course) instead of a debit card
—> The STEP allows you to double up payments any time (vs TD where you may only increase payments on an ongoing basis, and only once per year by up to 100%)

* We’re finding Scotia’s interest rates just as competitive as TD at the moment (e.g. Scotia’s 1-year rate is in the mid 2’s or less, for approved borrowers)

* The inconsistency among branches is not something we see in the broker channel. When we arrange a Scotia STEP for someone it is always 100% automatically readvanceable. The only exception is if a client is relying on stated income as opposed to proving their income in the traditional manner. The minimum readvance is a straightforward $100.

We have found TD to be amazingly competitive much of the time. We were still getting 2.1% for a 1-year on Friday (although it will apparently be up Monday). This is a lot lower than everyone else just during the last 2 weeks. As you mentioned, other banks are like Scotia closer to the mid-2s.

Scotia allows direct investing now? If they do, then it is a recent change. Or do you just meant they allow transfers to Scotia investing accounts?

When we talk about direct investing, we mean being able to use a void cheque from the credit line for a direct automatic payment. TD allows this, as do several other banks. Our clients with Scotia have all needed an extra chequing account in order to do the Smith Manoeuvre properly.

We would have to confirm the direct investing. Have you found you can believe the banks? When we talked to various banks about whether or not we could invest directly from their credit line by using a void cheque, some said yes and some said no. We eventually found from experience with clients that every single bank was wrong about their own product! It did not work with all the bank that said it worked, and it did work for all the banks that said it didn’t. Weird, isn’t it? Have you found that?

We would actually never recommend the options you mentioned about having a fixed/variable split or multiple mortgage portions in one mortgage. We always have specific recommendations for our clients on what term is the smartest to use at any point in time.

In addition, having 2 mortgage portions means you lose negotiating power on the due date, so we would always recommend against those options.

The downside of TD for us is that they charge legal fees and occasionally appraisal fees as well. We have some other providers that absorb all the fees.

We do business with TD as well and they’re a great bank, but their HELOC is much less flexible than Scotia’s (and other lenders) as noted in the previous examples.

Not to dwell on Scotia, but they do allow real-time transfers from the LOC to a ScotiaMcLeod Direct account. And if you want to use another brokerage you can set up automated monthly transfers from the LOC to a Gain account to a 3rd-party investment account. It’s completely hands-free once you set it up.

TD’s rates are good but if it’s all about the rate, there are other lenders with better. As of today, Scotia is still in the low to mid 2’s. National Bank is even more competitive on 1-year rates through the broker channel (definitely lower than TD today), and National Bank has the most flexible readvanceable mortgage in the industry.

Regarding banks, it’s imperative to talk to the right people. At the branch level I go straight to the manager for detailed questions. Lower level bank reps (even mortgage specialists) often don’t have the experience to answer questions about direct investing, auto-debiting the LOC, interest capitalization, etc.

As for hybrid mortgages (part fixed/part variable), I understand your point, but they are nonetheless very appropriate for certain types of borrowers. Moshe Milevsky, who you quoted in your article today, is a noted proponent of hybrids–despite authoring research supporting the long-term superiority of variable rates.

Regarding 1-year terms, I know you are a big advocate of them. From a purely mathematical standpoint they often have an edge given the right assumptions. The devil is in the assumptions. (I’ll touch more on this in post that pertains to your 5-year Mortgage Trap story.) Suffice it to say, I would never want to imply 1-year terms are right for all. Blanket statements about suitability make me feel like I’m walking in a minefield, so I try to avoid them.

Many people simply want long-term payment assurance, no hassle of having to renew each year, no uncertainty about what rate they’ll renew at every 12 months, no risk that this might be one of the 10-23% of times when fixed rates perform better than variable, no renewal fees, etc. We have to respect these viewpoints, despite what we ourselves believe to be the most advantageous term.

In cases where an individual requests a 5-year term, we’ll often look at their cash flow, risk factors, etc. and demonstrate how a floating/1-year portion diversifies interest rate exposure and reduces potential interest costs and risk. This is where the benefit of a hybrid comes in. A hybrid’s diversification ability generally offsets any lost negotiating power at renewal. That is why hybrids do make sense in specific scenarios.

Have you noticed that rates have declined again? This is probably temporary, but it looks like the fears of large mortgage rate increases were over-done.

Our experience is that what people want is usually because of lack of knowledge or advice about mortgages. Once people understand the facts about the huge interest savings, that they can still have fixed payments with variable, that avoiding penalties is important, and that effective negotiation requires that your mortgage comes due often and all at once, most will stick with 1-year fixed or variable rates.

There are a lot of places people can go to get offered “what they want” in a mortgage, but we think it is far more important to give people real advice and education in what is the smartest mortgage for their specific situation.

I guess my issue is that, in the last 20 years, there has been no time when I would personally have even considered any mortgage other than a variable or 1-year fixed (or shorter) – and definitely never a hybrid. That is why I would find it difficult to tell someone that they should take a 5-year fixed because they are nervous or broke, even though I would avoid them personally. I would rather address the nervousness with education and the broke situation by making sure they have an emergency source of cash.

Whether we are working with our clients or just referring someone to an SM mortgage, we look at the entire financial situation and how to structure it best – not just the mortgage.

Our experience is that once people are educated, have their financial situation setup properly, and get some real advice on what is smart for them, almost everyone understands the benefits of variable or 1-year mortgages.

The nature of our work has us monitoring rates by the hour, so we’ve been watching the reversal in yields since April and it’s been extraordinary. Most of the money markets (not just the mortgage market but fixed-income traders with billions of dollars of exposure) were on the wrong side of the trade this spring. The economic environment was just way more ominous than the market could have predicted.

Of course, hindsight doesn’t pay the bills. It will always be easier to predict today’s weather by looking out the window than by forecasting it three months in advance. Prediction is unfortunately a futile science. Rates are purely random and efficient beyond anything but the very short term.

In any case, you raise a lot of points and there is 100% agreement about the importance of:

• Education (hats off to sites like MDJ in this regard)
• Prudent planning and budgeting
• The overall long-term value of variable rates and 1-year terms.

However, a number of issues are not so clear cut.

Historical variable-rate savings have been established in academic studies, but those studies never included a rate environment like today’s.

Fixed payment variables are great, but not if: A) the trigger rate kicks in and misinformed consumers are shocked to see their payments rise; or B) rising rates reduces principal repayment and causes amortization extension (i.e. it takes you a few more years to pay off the mortgage).

Avoiding penalties is key, but not if it means selecting a term with refinance risk or budget risk–and the borrower can’t handle that risk.

Re-negotiation every year is okay (for some), but not if a 1-year term is unsuitable for your risk profile or the switching costs offset the savings.

The point is, each borrower’s circumstances are unique. It’s impossible to make the same recommendation to a 95% LTV first-time buyer with a 40% debt ratio and a 75% LTV renewer with a 20% debt ratio.

You and I happen to prefer variables over fixed rates, but it is commonly known that they are not appropriate for everyone. In fact, if a broker were to put every client in a variable, he/she would likely be in violation of suitability rules and could lose their license.

This is one example of why hybrids are a tremendous solution. People who would otherwise be compelled into choosing a long-term fixed rate can now diversify their rate risk and benefit from a variable as well. Borrowers can even tailor the rate risk precisely to their exact tolerance (it doesn’t have to be 50% variable. It might only be 25% variable. Moreover, if you keep the hybrid terms the same (e.g. choose a 3-year variable and a 3-year fixed) then you eliminate any chance of getting a poor rate on the short-term component at renewal.

In sum, as honourable as it is to stick to our convictions, it’s just as important to remain open-minded. A prime example surrounds all the research that’s cited in the mortgage industry. The last 20 years have seen interest rates decline steadily from 14.75% (in the case of prime rate) to 2.25%. That is an astounding 85% drop! By default, any rate study performed during this period has severe selection bias in that it will always favour variable and 1-year rates. To blindly extrapolate historical rate performance into the future (at a time when key lending rates are near their theoretical bottom) is therefore a gamble.

I’ll close on this note. We’ve had the pleasure of interviewing Dr. Milevsky (author of the industry’s most-cited fixed/variable research) on CanadianMortgageTrends.com. Here are a few of his own remarks that are pertinent for the times:

• “An environment like we’re seeing today brings into question any type of historical study.”
• “It’s not about speculating where interest rates are going.” (It can’t be done) “It’s about risk management.”
• There have been “periods of inversion” where fixed rates were actually lower than variable rates. Dr. Milevsky’s original study found that 10-12% of the time it pays to be in a fixed rate, “and this might be one of them,” he states.

The moral is: No one knows what tomorrow has in store. As mortgage planners, our primary duty is therefore to protect our clients from the downside while relying on correct probabilities to maximize the upside.

By the way, rising rate environments have favoured variable over fixed much more than falling rate environments.

You are right that interest rates have fallen 85% in the last 20 years, which is part of why variable rates have cost less. However, if you look at studies of rates from 1950-1975 (like Moshe Milevsky’s) when rates shot up about 2% to about 15%, the variable rate beat the 5-year fixed 100% of the time.

In rising rate environments, there is generally a bigger difference between the 5-year fixed rates and short term or variable rates.

We don’t expect large rate increases – just a rise of perhaps 1.5-2% from the bottom over a couple of year back to a more normal interest rate level. But my point is that rising rate environments are even more convincingly in favour of variable rates than falling rate environments.

That’s an interesting conclusion and there’s lots we can delve into there, but first may I ask:

* Which rate were you referring to rising from 2% to 15% in 1950-1975?
* Which particular study have you cited with respect to variable rates beating fixed rates 100% of the time during that time period?

I am a real estate agent in Ottawa and there is a lot of talk in my office about interest rates this year. I am buying a home and moving in 3 weeks, have to make a mortgage decision soon/

Here is my situation. Need to get 268k mortgage. Want to do SM

In december 2010, I got pre-approved for President choice 5 year fixed at 3.52% the rates when up across board.

Option 1. Go with PC at 3.52% and get Manulife1 in second position at prime+0.50%. Manulife said they will let me to increase the LOC once anually, by the pre-payment please note pre-payment and not premiums.
The PC has 20% prepayment, anytime, any amount per year. No revolving LOC with PC, only normal loc.

Option 2: Another Bank offered me prime-0.90% or fixed 5 year for 3.89% prepayment 20% any amount, anytime and I can double up each payment. Get revolving line of credit at prime+0.50%
Get a mixture of variable and fixed…but who knows by how much the rates will go up from now until 5 years is out……

Option 3: Another bank offered prime-0.90% and/or fixed 5 for 3.69% but the pre-payment is only 10% and only one lump sum in a year, plus douple up the payment option…
The diffrence between 3.52% and 3.69% is around $2,000 in extra interest over the 5 year term.

Option 3: get just the variable for 268k with revolving line of credit

Option 4: get jusr the fixed at another bank for 268k with revolving line of credit. Painful since I have to swallow extra 2,000 in interest. Difference between 3.52% and 3.69% and between 3.69%
and 3.89% additional 2500 in interest…..

Goals:
1) Get HELOC for the maximum amount against my residential property. Then use part of this HELOC as 20% down payment to buy a rental property.
2) Get following rate.
a) 5 years variable Mortgage: Prime – 0.90
b) HELOC: at Prime (currently at 3.0%)

@OttawaGuy, you could go the route of traditional mortgage + HELOC which would give you a 160k credit limit. Or you could go readvanceable which is basically the same thing, but allows you to tap into your equity as it’s available. I would pick the one that gives you the best overall rate.

The key for setting up the HELOC is to be able to track each type of investment separate. You should have one credit line for the SM and a separate one for a rental property. Both should be separate from any non-deductible borrowing.

The reason for this is that the interest for each type of investment is entered on different lines on the tax return. Also, if you sell some investments or a rental property in the future, you need to be able to track which credit line to pay them against, so you can track the remaining deductibility of each credit line.

The articles posted on this Canadian Personal Finance Blog are the opinion of the author and should not be considered professional financial advice. Please consult a financial professional before even considering using the information obtained from this blog.